Traders who execute orders in Exchange-Traded exotic options for the insurance industry now are being offered a new settlement technique on a major exchange.
In remarks made at CBOE’s Risk Management Conference U.S. (RMC) in Bonita Springs, Florida, CBOE Holdings President and Chief Operating Officer Edward Provost today announced that the Chicago Board Options Exchange (CBOE) plans to offer FLEX index options with Asian and Cliquet style settlement beginning Monday, March 21.
FLexible EXchange (FLEX) options, created by CBOE in 1993, are customizable options that allow users to define various contract terms such as exercise style, strike price and expiration date. FLEX options also give investors the opportunity to trade on a larger scale with expanded or eliminated position limits.
According to a press release, CBOE wrote that insurance companies that write indexed annuity contracts often have exotic option liabilities embedded within those annuity contracts. Two common types of exotic options are Asians and Cliquets. Insurance companies seeking to hedge embedded exotic option risk have historically traded exclusively in the over-the-counter (OTC) market. The introduction of Asian and Cliquet FLEX index options is expected to provide insurers with an alternative hedging tool to OTC market products, while also providing traditional exchange-traded benefits like enhanced price discovery, transparency and centralized clearing.
“CBOE is pleased to offer indexed annuity writers with new options-based hedging alternatives,” said Provost. “Transacting on an exchange may provide insurance companies with improved execution prices on their hedges, while simultaneously reducing counterparty risk.”
An Asian option, also known as an “averaging option,” is an option whose settlement value is based on an average of the underlying index closing prices throughout the contract’s life, as opposed to the single price at expiration.
A Cliquet option, sometimes referred to as a “ratchet option,” is a series of at-the-money forward-start options where the total premium is determined in advance. CBOE is expected to offer a specific type of Cliquet known as the monthly sum cap with a global floor where the option holder receives the greater of zero or the sum of monthly capped returns.
Both Asian and Cliquet FLEX index options have a term of approximately one year with 12 monthly observation dates, but each contract type has a different method for determining the exercise settlement value.
